Global Financial Crisis

The United States and China have become the rivalling hegemonic economies today and their relationship has across-the-board repercussions on international trade as well as on other countries’ economies. The linkages of these two economies have become very conspicuous, especially through the movement of goods and services, capital, and human labor. These existing linkages have tremendously expanded to the point where they have engulfed political and military matters, which will not be included in my central argument. Given the existing relationship between the United States and China, the global financial crisis has exacerbated such relationship through economic policies undertaken by each country. U.S. regulatory and policies may well bear the largest part of the blame for the global financial crisis. Subsequently, emerging markets such as China and its economic policies have made relatively easy for the United States to import cheap manufactured Chinese goods as well as enabled the U.S. to avoid short-term crises. Nonetheless, the consequences of those policies rebounded on the Chinese economy itself during the global financial crisis.

I will hence focus the paper on analyzing the global financial crisis–through the dependency theory and neomercantalist policies by emphasizing on both the U.S. and China’s foreign economic policies. Moreover, I will closely scrutinize the existing trade relationship between both countries in order to analyze the effects of this shock on the U.S. and China. I will do so by analyzing China’s policies such as: restrictions on capital outflows, protectionist policy of issuing a stimulus package, and trade and export expansion beyond the U.S. As for the U.S., I will focus on the decision to decrease trade value and imports from China, bailing out financial institutions, and an expansionary fiscal policy.

I argue that the global financial crisis altered the trade relationship between the U.S. and China in substantial ways through a sharp decrease in trade and the economic policies adopted by each country in order to redress their economies. According to the Neo-mercantilist theory would claim that, first, the U.S. would cut deep their demand and import of Chinese manufactured products and rather focus on protectionist policies and the maintenance of its position as a hegemon. Subsequently, Neo-mercantilist would also argue that China is in a better position than many other countries to withstand the global financial crisis as a result of its conservative and prudent fiscal policies placed an emphasis on saving and investing its earnings, rather than on consumption. On the other hand, dependency theorists would point out that the U.S. is also defectively dependent on China and hence vulnerable because of China’s holdings of U.S. Treasury securities. As a matter of fact, when China purchases U.S. government securities, China is lending money to the United States and helping the United States fund the U.S. federal deficit. Without the infusion of funds from China, the U.S. government would need to find other ways to raise revenue or otherwise engage in painful budget cuts.

According to the dependency theory, an economic model like China’s is heavily dependent on its trading relationships with foreign countries for its continued growth China’s export-oriented manufacturers would terribly suffer as their major market is the U.S. and they depend on the U.S. market and American consumers. Moreover, while China’s direct exposure to subprime mortgages may have been limited, the effect of the subprime mortgage problem did affect China because the problem had a significant and harmful impact on the economies of one of China’s largest trading partners: the United States and China’s dependence on an export driven economy and an economy dependent on [American] FDIs for growth.

The global financial crisis hence impacted both the U.S. and China through economic policies, the trade and value of exports and imports between both countries.

Overview of the Global Financial Crisis:

The existing literature highlights some of the key causes of the global financial crisis, which eventually ramified and impacted China. A global financial crisis that began in the U.S. slowly reached and impacted global economies including China. While, it is quite hard to single out the U.S.– as the sole responsible for the global financial crisis–where it all began, other countries have also played a significant in the unfolding of the global financial crisis. Some argue that emerging markets such as China contributed to the United States ability to borrow cheaply abroad and thereby finance its unsustainable housing bubble and avoid the short term ticking bomb.

As an illustration, many scholars attribute the origins of the financial to the mortgage lending markets. The financial turmoil that engulfed the U.S. during 2007–2009 began in the mortgage lending markets. Indicators of the emerging problems came in early 2007 when, first, the Federal Home Loan Mortgage Corporation announced it would no longer purchase high-risk mortgages and, second, New Century Financial Corporation–a leading mortgage lender to riskier customers–filed for bankruptcy (Marshall 7)[1]. As time went by, the crisis started to take a more permanent turn as housing prices began to spike down drastically and lenders/home owners sought new means to recover whatever amount of money they could from renters and loan grantees. What follows next is the realization that it was quite difficult for the mundane American to repay their loans. Most importantly, a growing lack of trust was transpiring and channeled towards debtors and their ability to make their interest payments. As a matter of fact, “the increased risk restricted the ability of the issuers of these financial products to pay interest, and reflected the realization that the bursting of the U.S. housing and credit bubbles would entail unforeseen losses for asset-backed financial instruments. Between the third quarter of 2007 and the second quarter of 2008, $1.9 trillion of mortgage-backed securities received downgrades to reflect the reassessment of their risk” (John Marshall 7)[2].

In September and October 2008 the crisis hit the broader banking industry. Investment bank “Lehman Brothers files for Chapter 11 bankruptcy petition after the failure of official attempts to arrange for the 158-year-old firm to be taken over by another private firm” (Pauly 241)[3], and for also having failed to raise the necessary capital to underwrite its downgraded securities. All in all, the failure of Lehman Brothers demonstrated that the government was not willing to bail out all banks, and this eventually caused an immediate spike in interbank lending rates. In response to such news, the financial markets became highly volatile. Investor confidence fell considerably, which was reflected in the fight to protect assets like gold, oil and the US dollar.

As the largest developing country and an export-driven economy, it would have been impossible for China to avoid the impact of the global financial crisis. However, “even if China’s economy is heavily dependent on the United States, which is one of the largest target markets for China’s exports and one of the largest foreign investors in China” (). China was able to successfully handle the negative impacts of the Global Financial Crisis through its existing approach to trade with the US and other countries as well as a series of policies and government stimulus package to shield its economy from a downfall. I will thus extrapolate on three of the foreign and somewhat domestic policies implemented by China as a response to the global financial crisis.

A.   China’s Policy response to the Global Financial Crisis:

1.     Restrictions on Capital Outflows:

China places numerous restrictions on capital flows, particularly outflows of capital to foreign destinations. These policies limit the ability of Chinese citizens to invest abroad, thereby compelling many Chinese citizens and private firms to invest their savings domestically in People’s Republic of China (PRC) banks, the stock market, business ventures, and the real estate market. “The PRC government accounts for the bulk of foreign investment overseas, much of it derived from China’s massive foreign currency reserves. But the PRC government invests mainly in safe low-yielding instruments, such as U.S. Treasury securities. As of June 2008, the U.S. Treasury Department estimated that China’s holdings of U.S. securities totaled $1.2 trillion, up from $922 billion in June 2007” (Chow 63)[4]. Neo-mercantilists would first point out that wealth is neither finite nor fixed, and in order for China to achieve their goal of rivalling the U.S. by engaging in protectionist policies or by seeking surplus and hence maintain a favorable balance of trade. The strict and protectionist restriction on capital outflows imposed by the PRC government seeks to maximize China’s national goals as hegemonic power that other countries–including the U.S. depend on. In so doing, the interventionist Chinese government can somewhat regulate the effects of external financial shocks on its economy and citizens.

On the other hand, the dependency theory would point out the dominant PRC government acts as the center that dominates its citizens and local firms that act to some extent as the periphery. While the Chinese government claims to protect the interests of its citizens, it is simultaneously trading with the U.S. government and its top giant firms. Ultimately, the core of the U.S. and China that take of the form of each country’s government and firms–who are one and the same according to the alignment of their interests–will eventually exploit the poor in each of their countries separately and by joining forces as well. Nonetheless, It is still quite hard to assess the ramifications of this protectionist policy through the lens of the dependency theory because the predictions of this theory are very limited in this particular case.

2.     Indigenous Innovation Protectionist Policy:

During the global financial crisis, a protectionist attitude clearly manifested in China’s new indigenous innovation policy of its government procurement program, which calls for the government purchase of technology that has been developed exclusively in China. Under this new policy, “the People’s Republic of China (PRC) government will purchase technology (products or services that embody intellectual property) for its many public works projects only if the technology was developed exclusively in China. China’s economic stimulus package of $586 billion calls for the government purchase of products for China’s numerous public works projects, but the indigenous innovation policy might block the United States from any opportunities to sell its products to China” (Chow 69)[5]. This new protectionist policy is part of a larger stimulus package designed to bail out and support national firms by directly infusing cash or investing in them in order to avoid possible damages incurred by the Chinese economy as a result of the global financial crisis.

This indigenous innovation protectionist policy qualifies as a neo-mercantilist policy due to the fact China created an economic stimulus package in order to redress its economy and protect its domestic firms against the nefarious damages of the global financial crisis. China’s government sought to maximize the country’s own wealth and protect their own interests by not only purchasing technology developed in China, but also by offering an economic stimulus package to help boost domestic companies’ productivity. Subsequently, the PRC government is able to directly purchase public work projects, which again highlights the interventionist nature of the PRC government. Finally, this new policy also enables China to keep maintaining a trade imbalance with the U.S. as it continues to import heavily from China, without necessarily being able to export to China. This new policy hence keeps the U.S. further away from its objective of stabilizing its trade balance with China.

The dependency theory would suggest that the Chinese bourgeoisie and the state will either separately or jointly exploit the proletariat in the Chinese context. Nonetheless, the dependency theory still presents a number of limitations. Even though the PRC government winds up exploiting the poor in its country, it has still offered an economic stimulus package of $586 to support domestic and public work projects. The dependency theory does not sufficiently cover the instances in which state governments–such as China provide economic stimulus packages to support its domestic industries and public work projects in exclusively China.

3.     Trade and Export Expansion beyond the U.S:

Trading relationships between the U.S. and China have come under severe pressure as a result of the global financial crisis. On a broader policy front, many argue that China has become overly dependent on the United States and that it needs to find alternative markets and trading partners. During the global financial crisis, China began to strengthen its trading relationships with other countries in Asia through the development of free trade agreements (FTAs), which eliminate most or all tariffs between trading partners. Moreover, FTAs create trade among its members, but also divert trade from non-members. “These FTAs may have a negative impact on U.S.–China trade. If, for example, goods from Japan can enter China subject to zero tariffs, then U.S. imports, which are subject to normal tariffs, may be displaced by Japanese goods. China is leading efforts to create free trade areas in Asia and may even eventually help to create a Pan-Asia free trade area. China may also seek to establish an Asian Monetary Fund, one that can compete with the International Monetary Fund in providing loans to developing countries. A leading role in the Asian Monetary Fund could bolster China’s influence with developing countries and allow China to compete with the United States for the allegiance of these countries by making “no strings attached” loans” (Chow 80)[6]. China has therefore used the global financial crisis to strengthen its economic relationships with certain countries–i.e., Iran–in order to meet China’s seemingly excessively growing energy needs. Of course, China has already established relationships with such a state. However, additional unwanted pressure from the United States to reform its currency policy and to remove subsidies from important state–owned enterprises might have pushed China into further expanding and deepening this particular relationship. Both to serve its own needs, but also to send a signal to the United States that its pressure tactics may have long–term negative repercussions for United States’ foreign policy and global interests.

In sum, China places much of the blame for precipitating the global financial crisis on the United States because the U.S. financial industry created the subprime mortgage problem. In other words, China believes that it (and the rest of the world) has been harmed by a financial crisis that is largely the doing of the United States. China is in a better position than many other countries to withstand the global financial crisis: its conservative and prudent fiscal policies placed an emphasis on saving and investing its earnings, rather than on consumption. This has allowed China to have the resources at hand to finance and implement a $586 billion economic stimulus package. However, China now finds that its economic stimulus package, designed to alleviate the effects of the global financial crisis, might come under challenge by the United States and might be the subject of trade sanctions imposed by the United States. Moreover, China’s economic recovery package is designed to address a fundamental imbalance in China’s economy: an overdependence of exports and FDI. The package is designed as part of a shift to a model of economic growth that creates an important role for domestic consumption as a driver of growth and will further create a sustainable economic model for the foreseeable future.

B.    The U.S. Policy response to the Global Financial Crisis:

1.     A Decrease in Trade (import) Value from China:

As a result of the global financial crisis, China’s largest target export market: the United States has considerably slowed their purchases of Chinese exports. As a matter of fact, consumers in the United States did not spend much as a result of the financial crisis, and China’s exports did decline significantly. Foreign Direct Investment (FDI) inflows from the United States to China did also decrease sharply during the global financial crisis “as cost cutting measures by multi-national companies (MNCs) have resulted in low availability of capital for foreign investment. In April 2009, FDI inflows to China were down by 22.5%, as compared to April 2008 when FDI surged by over 70%” (Chow 64)[7]. The declines in merchandise trade, the influx of FDI, and exports from the United States have led to sharp retractions of China’s economy.

The United Stated hence took significant measures in order to shield its economy, firms, and citizens from the lasting effects of the global financial crisis. The U.S.’ foreign policy of sharply reducing its purchases of Chinese exports exposes a rather (neo-mercantilist) protectionist policy. Even if Chinese manufactured products were easily accessible to the U.S. and relatively very affordable, the U.S. opted to safer its market and crumbling domestic firms and institutions at the expense of its existing trade relationship with China. Consequently, China incurred somewhat significant financial losses as its main export market: the United States reduced its volumes of trade.

From the standpoint of the dependency theory, China’s dependency on the U.S. has proven to be a disadvantage in this particular instance. First, through a sharp decrease in the purchase of Chinese exports. Secondly, Foreign Direct Investment (FDI) has also tremendously decreased as a result of this policy carried out by the U.S., which ultimately affect local Chinese workers, infrastructure projects, and technological advancement and overall economic development.   Foreign direct investment (FDI) refers to the injection of capital into China by foreign investors (mainly multinational corporations). An example of FDI occurs when a U.S. company establishes a subsidiary in China for the purpose of conducting business in China. FDI is important to China’s economy for several reasons. First, many foreign-invested enterprises (FIEs) are engaged in exports of goods from China, helping China fuel its growing trade surplus with the United States.

Second, FDI plays a crucial growth in China’s economic development by providing a massive influx of capital. In order to establish these business entities, the U.S. company will be required by the PRC government to inject capital into China to meet the business entities’ physical needs, such as building a factory or office buildings and purchasing equipment and supplies. Further, the newly established business entity will need to hire local workers, providing employment opportunities for new graduates of China’s universities.

Third, FDI also provides the crucial component of technology transfer. In most cases, the foreign investor will need to transfer or license its technology to the business entity in China in order for the business to operate successfully.

The role of FDI is crucial to China because FDIs provide capital, thereby resulting in new construction projects and, more importantly, providing China with the access to advanced technology that is crucial to competitiveness in the modern world. Consequently, a sharp decline in FDI from the United States to China will therefore severely jeopardize Chinese economic plans and damage its economy to some extent because of its dependence on FDI from the U.S and U.S. purchase of Chinses exports.

2.     Bailing Out Financial Institutions

As in the case of China’s economic stimulus package, the United States also ventured in bailing some its institutions and enterprises. As a matter of fact, some of the Federal Reserve’s liquidity provision was to bail out financial institution, as occurred with Bear Stearns, AIG, and the government–sponsored enterprises Fannie Mae and Freddie Mac. In each of these cases, “the Federal Reserve provided this liquidity in cooperation with the U.S. Treasury, which also made large loans. Although the Troubled Asset Relief Plan (TARP) was initially intended to purchase subprime mortgage assets to help prop up financial institutions’ balance sheets” ( Mishkin 16)[8]. The Treasury opted for the sound decision of injecting capital into financial institutions, thereby boosting their balance sheets more directly. In addition, the U.S. Treasury announced a Temporary Guarantee Program for Money Market Funds, which insured that investors would receive at least the $1 par value per share. Although these programs were initially intended to last less than a year, they have been extended several times during the global financial crisis in an effort to mitigate the dire consequences of the crisis.

This U.S. policy parallels one part of  China’s economic stimulus package, which aimed at sponsoring domestic industries and purchasing public projects as well as exclusive technology produced in China. The U.S. hence engaged in similar a neo-mercantilist policy by protecting domestic firms and their growth. Although this was supposed to only last less than year–it rather created a dependency relationship between the U.S. financial institutions and the U.S. Federal Reserve. If such a policy was truly successful, then I would assume that there would be less reliance on the program implemented by the Federal Reserve. Some would argue that the U.S. relied on a neo-mercantilist policy in order to “strengthen confidence and encourage liquidity in the banking system. Nonetheless, the dependency theory would probably emphasize how a these companies being bailed by the U.S. government and the Federal Reserve exploit the working American class. Regardless of the potentiality of such a claim, restoring the financial capabilities of U.S. domestic firms means an increase in employment.

3.     Expansionary Fiscal Policy

Lastly, the United States also issued an economic stimulus package. Fiscal stimulus to directly increase aggregate demand was another key piece of the government response to the global financial crisis, both in the United States and in many other countries such as China. “The incoming Obama administration pushed for the $787 billion fiscal stimulus package, the American Recovery and Reinvestment Act of 2009. The plan featured $288 billions of tax cuts and $499 billion in government spending increases” ( Mishkin 17)[9]. The evidence on the effect of the fiscal stimulus package is mixed, as many would suggest that it was far less important to addressing the financial crisis than were actions by central banks to provide liquidity and government recapitalization and guarantees of the financial system. First, as a basic matter of timing, most of the additional government stimulus package did not come on line until late 2009 and into 2010. While one can construct a theoretical argument that the expectation of the stimulus package helped to reassure financial markets, any direct effect of the stimulus on the financial crisis through the early months of 2009 was necessarily quite limited. Even if the stimulus package did not come as soon as expected, the fact that it was speculated it was going to be implemented really helped strengthen confidence and the possibility of curbing the global financial crisis.


  1. Marshall, John. (2009). ‘The Financial Crisis in the US: Key Events, Causes and Responses [Abstract].’ House of Commons Library, 09(34), 1-55.
  2. Marshall, ‘The Financial Crisis in the US: Key Events, Causes and Responses [Abstract].’, 7.
  3. Pauly, Louis W. ‘The Political Economy of Global Financial Crises.’ In Global Political Economy, by John Ravenhill, (2017). 226-52.
  4. Chow, Daniel C.K. ‘China ’s Response to the Global Financial Crisis: Implications for U.S. – China Economic Relations.’ (2010), 46-81.
  5. Chow, ‘China ’s Response to the Global Financial Crisis: Implications for U.S. – China Economic Relations.’, 69.
  6. Chow, ‘China ’s Response to the Global Financial Crisis: Implications for U.S. – China Economic Relations.’, 80.
  7. Chow, ‘China ’s Response to the Global Financial Crisis: Implications for U.S. – China Economic Relations.’, 64.
  8. Mishkin, Frederic S. ‘Over the Cliff: from the Subprime to the Global Financial Crisis.’ (2010), 1-32.
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